ARE WE SET TO ROCK?
As investors, we all know that the ideal strategy is to sell out of the market before it goes down, then reinvest just as it begins to go up. However, as good as this sounds, in reality this strategy is impossible to execute. How do we know when to sell, and when to buy? There’s an old Wall Street saying that nobody rings a bell at the top of the market, or at the bottom.
After a sharp decline in the market, we naturally want to sell to avoid the potential for further drops in our portfolios. Not only does that lock in our losses, but it also raises the question about when do we reinvest again? Historically, there have been no indicators that have consistently predicted the direction of the market. Even the economy is not a reliable predictor as it often rebounds months before an economic recovery is evident.
So, if top quality stocks, caught up in this across the board market decline, are trading at rock bottom prices, why aren’t we rushing in to buy them? We all love to bargain-hunt at our favorite stores (don’t we?). Why don’t we do the same on Bay Street?
Well, because while volatility is not unusual, it is unsettling. That’s why its important we remember that in every instance that the stock market declined, it eventually regained its losses, then went on to achieve even greater new highs. Two hundred years of market history has proven this.
When the market does recover, its gains come in bursts. Missing those few days or months of strong returns can have a huge impact.
For example, an investor who stayed invested in the Canadian stock market over the 10 years ending in 2007, would have had an average annual return of 10%. Missing just the 10 best days would have reduced returns to 5.7%, while missing the 30 best days would have resulted in negative returns. Obviously selling low, then missing the subsequent uptick, results in worse returns than the market’s average performance.
We don’t need to go back too far to when this happened last.
What followed the 2000 to 2002 market decline (Recession, World Trade Center attacks, Technology Crash, Corporate Accounting Scandals) was the beginning of a new bull market. Investors who sat on the sidelines ended up missing out on the big gains that followed, particularly in the early stages of the following rebound.
Most unfortunate is that some investors who realize losses may never reinvest in the stock market again. They end up doomed in low interest bearing investments, that after tax and inflation,provide them with no opportunity to recover their past losses, or enjoy the growth they will need to achieve their future dreams and goals.
Consider this novel way to look at short term volatility versus long term market performance. Imagine that you are riding on an escalator, playing with a yo-yo. While the yo-yo is constantly in motion, regardless of whether it happens to be up or down at any given moment, the bigger picture is that you’re on the escalator and are moving up. The stock market acts the same way. The market’s day to day volatility is like the yo-yo, but if you step back and look, the long term trend is that over time the escalator is taking you to new highs.
Besides staying invested, we all need to remember other strategies proven over the long term:
- Be diversified amongst different types of stocks, bonds and cash. This should include small and large companies in different industries, located throughout Canada, the US and Internationally.
- Take advantage of market volatility through regular re-balancing, and dollar cost averaging.
- Keep a long term perspective, and don’t get caught up by dire headlines in the media. These only create a sense of urgency and fear, and compel you to make bad decisions. Recessions do end, good businesses continue to operate, and both markets and economies recover and grow.
- Your ZLC Associate will help you make any changes necessary so that you will achieve your financial goals. Dalbar, a leading financial-services market research firm, show that investment returns increase when investors are disciplined, and that most investors need the help of an advisor to provide this discipline.
